BASF Wyandotte Corp. v. C. I. R., 75-1596

• Decision Date: 04 March 1976
• Docket Number: No. 75-1596,75-1596
• Citation: 532 F.2d 530
• Parties: 76-1 USTC P 9268 BASF WYANDOTTE CORP., formerly Wyandotte Chemical Corp., Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 530

532 F.2d 530

76-1 USTC P 9268

BASF WYANDOTTE CORP., formerly Wyandotte Chemical Corp. Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 75-1596.

United States Court of Appeals, Sixth Circuit.

Argued Oct. 14, 1975.

Decided March 4, 1976.

Steven Uzelac, Miller, Canfield, Pattock & Stone, Paul R. Wassenaar, Detroit, Mich., for petitioner-appellant.

Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Jr., Gary R. Allen, William A. Whitledge, Tax Div., U. S. Dept. of Justice, Washington, D. C., for respondent-appellee.

Before PHILLIPS, Chief Judge, McCREE, Circuit Judge, and McALLISTER, Senior Circuit Judge.

McALLISTER, Senior Circuit Judge.

This is an appeal from the decision of the United States Tax Court holding that appellant is liable for deficiencies for the taxable years of 1964 and 1965 in the amounts of $5,228.65 and $156,027.87, respectively, in which Judge W. M. Drennen filed an opinion and findings, and entered the decision reported in 62 T.C. 704.

At the outset it should be observed that the facts in the case are undisputed. The only questions involved are questions of law and the interpretations of the law as applied to the facts. While the facts are undisputed, it is necessary to recite them at length since the case is a complicated controversy of tax law and, without the factual background, the conclusions reached by the Tax Court and the arguments of the parties would be difficult of comprehension. The briefs of the parties are notable. Government counsel's brief is worthy of remark, and counsel for appellant, Wyandotte, have ably and cogently advanced every argument that could be made for their client.

In Judge Drennen's opinion and in the stipulations filed, the facts are fully stated and therein it appears that petitioner-appellant was a Michigan corporation with its principal offices in Wyandotte, Michigan, at the time its petition was filed; that appellant is the successor by merger to Wyandotte Chemical Corporation (Wyandotte), which was also a Michigan corporation, whose principal offices were in Wyandotte, Michigan. Wyandotte's returns for the years 1964 and 1965 were filed with the District Director of Internal Revenue at Detroit. Appellant Wyandotte kept its books and reports of income on the accrual method of accounting.

As part of its chemical manufacturing business, appellant-taxpayer, prior to 1965, owned and operated a steam-generating plant and an electricity-generating plant, both of which, as above stated, were located in Wyandotte, Michigan, taxpayer's principal place of business. These plants were used to supply steam and electrical power necessary in taxpayer's chemical manufacturing processes. Taxpayer had constructed these plants over a period of years and originally computed the useful life and depreciation deductions separately on some 1,500 individual items of equipment contained in the power plants. Involved in this appeal are the items of power-plant equipment (turbo-generators, boilers, motors, pumps, switches, conveyors, turbines, power lines and similar items) which the taxpayer had depreciated under the straight-line method of depreciation from the acquisition of each item until January 1, 1962. Only the equipment depreciated on a straight-line basis is involved in this case, which was referred to by the Tax Court as "straight-line properties." Some of these items of equipment had been acquired as early as 1926 and, on January 1, 1962, many items had been fully depreciated, thus having a basis of zero.

We have taken much of the foregoing from the opinion of Judge Drennen as well as from the brief of the Commissioner, and we shall continue outlining the statement of facts by freely taking from the court's opinion and from the briefs of the parties without attribution thereof, except where specifically indicated.

The aggregate original cost of the straight-line properties was $9,955,116 and, prior to January 1, 1962, an aggregate of $7,109,791 had been allowed (or was allowable) as depreciation for tax purposes under Section 167 of the Internal Revenue Code. Thus, on January 1, 1962, the total undepreciated cost of the straight-line properties was $2,845,325.

In 1962, taxpayer made an election (effective January 1, 1962) pursuant to Section 1.167(a)-7(a) of the Treasury Regulations on Income Tax (1954 Code) (26 C.F.R.) to depreciate all its straight-line power plant property and other numerous items of machinery and equipment used in its chemical business in one open-ended multiple asset account. The taxpayer transferred property (including the straight-line power plant properties) with a total original cost of $62,865,357 to its newly-formed multiple asset account. Total depreciation allowed or allowable in prior years (including depreciation attributable to the straight-line power plant properties) amounted to $45,865,357, leaving a basis for future depreciation of $17,060,606. For 1962 and subsequent years, taxpayer computed its depreciation on the multiple asset account under the straight-line method using an eleven-year useful life, pursuant to Rev. Proc. 62-21, 1962-2 Cum. Bull. 418,422 (chemical and allied industries). Subsequent to January 1, 1962, taxpayer purchased new power plant equipment at a cost of $32,316, and such equipment was added to the multiple asset account. Under Rev. Proc. 62-21, supra, depreciation is computed on the basis of total original cost of the multiple asset account regardless of whether or not the individual assets in that account have been fully depreciated. In 1965, the taxpayer incurred sufficient allowable depreciation to reduce the undepreciated basis of the multiple asset account to zero.

On December 18, 1965, taxpayer sold the steam and electric generating plants to Detroit Edison Co., and thereafter purchased its power and steam from Detroit Edison. The bill of sale recited that Edison purchased the buildings for $850,000 and the machinery and equipment for $3,150,000, but did not otherwise allocate the purchase price among the 1,500 items of power plant equipment. The taxpayer thereafter hired the American Appraisal Company (American) to appraise the property which appellant had sold, in order to allocate that part of the purchase price ($3,150,000), allocated by the bill of sale to machinery and equipment, among the 1,500 individual items involved in the sale. The report of the appraisal company stated that a field audit was undertaken to ascertain the "overall condition and physical depreciation associated with the property." The appraisal company report then explained how it had allocated the sale price among the assets:

"The $3,150,000 sales price for the entire list of assets was distributed to the individual items on the basis of estimated reproduction cost new less depreciation. The estimated reproduction cost new was obtained by trending the recorded original cost by subaccount groups to current cost levels by the application of appropriate index numbers. The estimated reproduction cost new less depreciation calculation reflects the estimated reproduction cost new in combination with the expired and estimated remaining life of the property, our field observations, and our knowledge of this type of property. The depreciation assigned considers all factors except economic considerations. The reproduction cost new less depreciation base for distribution of the $3,150,000 assumes that the property will continue in use and that the economic gain associated with the property through continued use would properly relate to the $3,150,000 supplied to us. The distribution of the sale price has been within one class of property, machinery, and equipment, and considers that the property items within this classification have similar depreciation characteristics."

In reporting its gain on the sale, taxpayer treated the amount of sale price allocated to each asset by American's appraisal report as the amount realized from the sale of that asset. Taxpayer reported the lesser of the amount of gain attributed by it to each item or the amount of depreciation it attributed to that item, or the amount of depreciation it attributed to that item for periods after January 1, 1962, as ordinary income pursuant to Section 1245 of the Internal Revenue Code of 1954. The remainder of the gain was reported as long term capital gain from the sale of depreciable property used in taxpayer's trade or business under Section 1231 of the Internal Revenue Code. Taxpayer reported a total gain on the sale of the straight-line properties of $1,775,854, of which $904,509 was treated as long term capital gain and $871,345 was treated as depreciation recapture under Section 1245. The Commissioner accepted taxpayer's allocation of $2,676,523 of the sales price to the straight-line properties, but determined that the entire gain was taxable as ordinary income under the depreciation recapture provisions of Section 1245, and issued a deficiency notice which explained:

"It is held that you realized a gain of $2,676,523 on the sale of certain machinery and equipment in 1965, and that all of such gain must be treated as gain from the sale of property which is neither a capital asset nor property described in Section 1231 of the Code."

The deficiency notice did not state the particular theory upon which the Commissioner was proceeding with respect to the determination that the entire gain on the straight-line properties was subject to the depreciation recapture provisions of Section 1245 but, at trial, counsel for the Commissioner indicated that he was relying on alternative grounds for this determination: (1) that the particular items in question lost their identity as individual assets for the purpose of Section 1245 computation after they were placed in the multiple asset depreciation account; and (2) that even if Section 1245 could be properly applied to the amount realized on the sale of...